Can't you also profit from an LBO if revenue and Exit Multiple decrease?
Hi guys,
why is a constant or even higher Exit Multiple or growth opportunities considered mandatory for an LBO candidate?
Isn't it enough to just pay off debt and change the equity portion to get a good IRR? Couldn't you also make substantial profit if the EV and Revenue or EBITDA slightly decline?
Best regards,
WVRHVMMER
It may be possible but I haven't come across any situations yet where debt pay down is the only lever.Most 2-3x MoIC returns over 5 years rely on EBITDA improvement, constant or improved EBITDA multiple and debt paydown.If you did dividend out all of the cash each year then it might go to the growth profile or capex the new owner might need to invest, which would negatively affect selling price.
Feel free to run the math - you can make it work under ideal pricing and growth / structure assumptions.
If you buy a company for 4x unlevered and assume 100% FCF conversion and flat EBITDA, then you'll make a 1.0x after 4 years from just cash flow and could turn a 2.0x MOIC if the multiple stays flat.
If you borrowed 3x to do it (i.e., paid 1x in cash) at 0% interest and fully amortized with the first 3 years of cash flow, then you make the same 1.0x after 4 years but that flat exit multiple earns you a 5.0x total MOIC - if you compress the exit multiple or assume EBITDA decline you could still end up with a pretty attractive return.
This becomes much harder once you layer in interest, CapEx, appropriate LTV assumptions, etc., but you could still probably construct a scenario where it works. However, your ability to pay is pretty capped, and you're not going to find many stable companies of any size with strong cash flows going for low single digit multiples these days (nor are many lenders going to finance microcap companies at 75% LTV). It becomes a lot easier to make returns work if margins are expanding, revenue is growing, multiples are at least flat, etc.
In the real world, it's pretty hard to find profiles like the above and you would have basically no margin for error. Nothing will ever go perfectly accordingly to plan, so having some leeway is key to sustainable underwriting.
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